Even in the best of times, a company’s disposition is a multifaceted process fraught with risk. With the current state of the economy, what you don’t know can be fatal. Still, there are techniques that can be used to avoid many of the dangers. For many small to medium business owners, the current economy can present an unprecedented opportunity to strengthen your exit strategies and receive the maximum value for your most important asset. Here are some numbers worth noting:
- Recent estimates show that 63% of entrepreneurs do not have a formal exit plan.
- More than 90% of North American companies are privately owned.
- According to the U.S. Census Bureau in 2004, there were more than 25 million U.S. businesses, the majority of which were sole proprietorships, partnerships, or LLCs.
This means that almost 16 million companies have no formal exit plan.
AICPA – Stud for Succession Planningj 35% of multi-owner businesses and 9% of sole proprietorships (sole proprietorships and sole proprietors) had a written succession plan in 2008, compared to only 25% of multi-owner businesses and 8% of sole proprietorships in 2004. *
Current Status of Succession Planning Multi-Owner Businesses Sole Proprietors
Have started the plan and will finish it soon. 35% 7%
Will the process begin in the next year or two 32% 43%
Will the process start in about 5 years 10% 23%
Will the process start in about 10 years 3% 3%
Have a plan drawn up, but not yet formally approved 9% 3%
*The 2008 PCPS follow-up study by AICPA
These undeniable numbers are compelling arguments for aggressively pursuing the most sophisticated strategies and state-of-the-art techniques for planning and implementing 21st century exit strategies, estate/wealth preservation plans, and strategic plans.
As an entrepreneur in today’s economy, business growth (or lack thereof) and trying to manage day-to-day operations determine how you will spend most of your time. However, there is no more compelling reason than the current economic situation for you as an entrepreneur to take steps to take advantage of trends and opportunities that will result in better valuation, lower tax consequences and smoother transitions as your liquidity event comes to fruition. Your future after you leave is also a concern. The sooner you plan for all contingencies, the better.
What are your options?
Traditionally, there are two main paths you can choose: sell to an external third party or transfer to insiders such as your employees or family members. There are essentially two paths entrepreneurs can take when they decide it’s time to move on to the next stage of life: selling the business to an outside party or handing over the business to “insiders,” such as family members or employees. Of course you can also liquidate, but this is usually not the chosen route, rather a forced or difficult route when no buyer shows up or other circumstances intervene.
Today, when selling to third parties, some options must be carefully considered, such as transferring 100% ownership or retaining some of the equity. While it may be tempting to try to walk away with a large amount of money, it may not be practical or in the best interest of the seller in the current state of our economy.
In light of the current economic climate, it may not be the smartest strategy for owners in industries where valuations are negatively impacted by the economy. Sell 100% of their stake when the market value is at a record low.
Some examples are real estate related companies, construction companies, car manufacturing/sales and retail. Instead of paying out, a second option is to sell only part of the equity and keep a share. The retained equity may be a minority or majority interest. In certain cases, a partial sale may be desirable because it allows the selling stakeholder to withdraw some of his net worth from the business so that he can diversify some of his assets while retaining some equity for potential future appreciation.
In uncertain economic times, the ability to release some of your net worth can help the company grow, increasing the valuation of the retained interest in the company. In fact, by selling a partial interest in your company, you can share future business risks and opportunities with a partner.
Acme Corporation was valued at $10 million and owned by one shareholder. However, in light of the current economic climate, the sole shareholder decides to sell 70% of its property to a third party. The result is a liquidity event where the selling shareholder obtains $7 million in blocked equity. The seller negotiates an agreement to remain involved in running the business, with a new owner bringing a fresh perspective to the company’s management and operating structure. By maintaining a significant minority equity position and joining forces with the outside buyer, the selling shareholder is set to participate in future growth as the economy recovers. This scenario also gives the buyer the assurance that the seller still has “skins in the game”. This vested interest in the company is beneficial to both buyer and seller. With a carefully crafted plan, the seller is positioned in such a way that the 30% stake could be worth significantly more than at the time of the initial transaction.
Another approach is to execute a transfer plan to insiders, such as family members, management or employees. In family succession, the internal transfer can be used to reduce certain tax consequences. This is because in the current environment, tax liability is likely to be reduced due to lower valuations. We’ve found that corporate valuations are generally lower than they were a year or two ago. The factors driving this range from lower revenues, lower profits, tight credit and lower valuation multiples.
The resulting lower valuations provide exceptional opportunities to transfer ownership interests to family members through a variety of techniques that protect or defer tax events and provide various other estate plans. Because interest rates are still relatively low, these techniques are being further improved. In addition, if your goal is to prepare the company for another sale to an outside party at a later date, the current environment is conducive to recapitalization and intra-family transactions to shift ownership and save taxes when the company is sold to the outsider in the future. future. A warning; as there is a very real possibility that hyperinflation could devalue our currency, you should carefully consider where you want to invest the money you receive at the time of transfer, to hedge against the eventuality. In addition, such inflationary conditions may reduce or erase any profits you enjoy from the retained equity interest.
The current slump in the economy can also encourage a sale to your employees. You may want to sell through a management buyout to select key managers, or through an employee ownership plan (ESOP). Again, lower valuations equate to better economics for buyers and potential tax savings for sellers.
How to proceed
Planning an orderly succession and obtaining the maximum liquidity of your ultimate disposal of your business requires a team approach. Bringing together the combined experience of leading tax, legal, insurance and finance professionals, you get an integrated strategy that addresses the many facets of your exit plan.
Case Study #1
John Smith, who owns 70% of ABC Manufacturing, LLC, wanted to plan his exit strategy. The value of his ownership percentage in the company was $4 million and he wanted to retire in 5 years, but the question was how? Using state of the art techniques, ABC Manufacturing, LLC agreed to borrow $4 million over 5 years to fund the premiums of an indexed universal life insurance policy for John’s life. John could then start receiving life insurance benefits after he leaves the company. The end result: This approach exceeded John’s expectations, offering more than 249% of what John expected to receive for the value of his property.
Retirement owner: male, age 46 Expected value of owner’s business interest: $2,500,000 Retirement benefits begin at age 55 Annual retirement benefits: $263,611 for 30 years Net death benefit: $659,700 Total benefits from this approach: $ 8,568,037 Portion of owner’s expected value obtained with this solution: 343%
Retiring Owner: Male, age 43 Expected Value of Owner Business Interest: $8,000,000 Retirement benefits begin at age 50 Annual retirement benefits: $760,125 for 20 years Net death benefit: $13,758,412 Total benefits resulting from this approach: $28,960 .918 Portion of expected owner value obtained by this solution: 362%
For these business owners, using our recommended techniques, the business owners were able to meet their business succession needs and facilitate financing for a smooth transfer of ownership, while ensuring potential tax-free retirement income.
To see yet another example of a strategy that mirrors current methods, see this article from the Wall Street Journal: Wall Street Journal Article
What is your exit plan?
If you’ve been putting off planning or implementing your exit strategies, now is a good time to stop procrastinating and start putting your plan into motion. The current atmosphere offers opportunities that we may not see again for years to come, if ever. Now is the time to take action for you. Like death and taxes, you eventually leave the company. Will your departure be on your terms or someone else’s?
Stop rationalizing, stop stewing. Get out of your chair and start doing! Dennis Waitley